It's as if we're wired for growth. "Growth is good." "If you're not growing you're dying." Everyone wants to be growing, personally, physically, mentally. Businesses are no different. Growing companies are rewarded a high multiple and low growth companies are rewarded low multiples. But is growth always good?
Growth in businesses is exciting. When a company is growing it's lively, employees are excited, customers are excited, there is momentum. It is fun to be a part of something growing.
The problem with growth is that it's hard to manage well. Humans seem to make the best decisions when they can assess the inputs, thoughtfully consider those inputs and make a decision. When a company is in the midst of rapid growth management doesn't have the opportunity to make thought out decisions. People need to be hired yesterday, customers are ordering things that don't exist yet, it's all hands on deck all the time.
Some of the excited from working at a growing company comes from the fact that no two days are the same. There are always new challenges. The reason for this is because the workplace is chaotic and employees don't have fixed roles yet. No two days are the same because on Monday you might be solving an engineering problem, and on Tuesday you're helping to pack boxes in the warehouse. When a problem comes up everyone huddles to figure out how to tackle it. Unfortunately playing whack-a-mole with problems isn't efficient, or sustainable way to conduct business.
Companies are successful when they can introspect, identify why they are successful and systematize their success. This systematization is the process that turns a start-up into something sustainable. It's also the point where most of the initial cowboy (or cowgirl) employees leave because a company has becoming "too corporate."
Companies are typically started by people who are willing to do anything at any time to get a job done. These are people who enjoy challenges and thrive in chaos. They are the people who are willing to try new things, but usually aren't very structured, they can't be. As a company grows it needs to become organized and organization doesn't come from the initial employees. It comes from new hires with experience in structured environments. These new hires usher in the second phase in a company's lifecycle. The sustainable corporate phase. Success is systematized and becomes sustainable.
Growth can kill companies when they refuse to systematize their processes and become corporate. This could be because a company's Founder doesn't want to lose their start-up culture. Or it could be that the initial management team doesn't know that it needs to systematize.
Eventually the chaotic fire fighting becomes unsustainable and a company collapses under its own weight. Unfortunately the collapse is sudden and unexpected. There isn't always a specific reason for the collapse. But the underlying reason is always the same. The chaos became unmanageable and obligations went unfulfilled.
The corollary to growing too fast are companies with little growth that never seem to die. These low growth companies are some of the stalwarts of value investing. Just like growth is lauded no growth is despised. Who wants to work for a company that grows at 3% a year? Even worse, who wants to invest in such a slow-poke?
The perception around low growth companies is fascinating. Even though most are exhibiting some absolute level of growth, even if small, investors see these as "dying" companies. They are dying in the eyes of the market because they're not growing fast.
Just as it's difficult to systematize a fast growing company it's hard to take a systematized low growth company and turn on the growth spigot. Low growth companies are set in their ways. Their ways are often successful in generating consistent returns, but not consistently high returns. Some of this could be due to their products or market, or it could be that the company doesn't know what needs to be changed to generate increased growth.
In the book Security Analysis the author Benjamin Graham discusses buying stocks and encourages the reader to look at a company's past growth history. He states that if a company had experience with growth or high earnings in the past then management is familiar with what it took to get there, even if they aren't experiencing it currently. This is preferable to a company that has never had more than middling growth. The implication is that the management team doesn't know what's necessary to create conditions that generate growth.
The world of venture capital investing is filled with carcasses of companies that grew fast and failed. Most of the companies didn't fail because customers didn't like their products, or there wasn't market demand, or they couldn't generate revenue. They failed because they grew too fast. Their growth was unmanageable and they grew their way to failure.
Venture capitalists are hoping to leech onto a company that can mitigate the growth landmines. They are looking to find companies that grow fast, but also figure out how to become corporate and sustainable.
Investors in public markets should avoid high straight line growth and instead favor companies with moderate, but sustainable growth. High paced growth is exciting for a while, but when the bottom falls out shares crash and investors become bewildered wondering "how could this happen?"
A company with sustainable growth can retain excitement from growing. But without out of control growth the investor stands more of a chance that they'll be able to enjoy the fruit of their growth investment. If you're in the market for growth don't be a moth attracted to the flame from a rocket investment. Rather look for sustainable growth identifiable by a management team that is corporate and has systematized their success.